1. Field of the Invention
The subject disclosure is directed to a system and method for updating valuation data necessary for determining the present worth of financial instruments, and more particularly, to a system and method for updating time-sensitive valuation data associated with pass-through securities, computing the financial outcome of transactions involving the pass-through securities and investors' portfolios and applying the computed financial outcome to the portfolios involved in the transactions.
2. Background of the Related Art
A pass-through security is a financial instrument which represents pooled debt obligations and passes income from debtors to its shareholders. The most common type is the mortgage-backed security, which represents an ownership interest in mortgage loans made by financial institutions to finance the borrower's purchase of a home or other real estate. Mortgage securities are created when these loans are pooled and “securitized” for sale to investors by agencies or corporations such as the Government National Mortgage Association (GNMA or Ginnie Mae) and Federal Home Loan Mortgage Corporation (FHLMC or Freddie Mac). Investors may purchase mortgage-backed securities from the issuer, when dealt in the secondary market, or from dealers in the open market, such as the Federal National Mortgage Association (FNMA or Fannie Mae).
As the underlying mortgage loans are paid off by the homeowners, the investors receive payments of interest and principal. Mortgage-backed securities provide a pass-through coupon rate, but repayment of the principal is given in increments over the life of the security, as the underlying mortgage loans are paid off, rather than in a single lump sum at maturity. Mortgage-backed securities may pay interest and principal monthly, quarterly or semiannually, depending on the structure and terms of the issue. Typically, the timing and speed of principal repayments vary, because the cash flow on mortgage-backed securities is also irregular.
For example, if homeowners whose mortgages are in a pool sell their homes, refinance their loans to take advantage of lower interest rates, prepay their mortgages for some other reason or default on their loans, the principal is distributed on a pro rata basis to the investors. When this happens, the investors' remaining interest in the pool is reduced by the amount of prepayments. Since the principal is reduced over the life of the security, the interest income decreases in terms of absolute dollars paid to investors. Thus, the pass through coupon rate of interest changes.
Mortgage-backed securities are sold and traded in terms of their assumed average life rather than their maturity dates, in part because of the aforementioned irregularities. The prepayment speed, which is the average rate at which mortgage holders are expected to pay off their loans ahead of schedule, is used in calculating the value of mortgage backed security. However, some mortgage loans could remain outstanding for the entire life of the original loans, which is typically thirty years.
To facilitate the determination of the prepayment speed (and in turn, the buying and selling prices), a decimal value known as the remaining principal balance (RPB) factor is utilized. The RPB factor (also known as the “pool” or “pay down” factor) reflects the proportion of the outstanding principal balance of a mortgage-backed security, which changes over time, in relation to its original principal value. Certain institutions publish monthly factor reports containing a list of factors for Ginnie Mae, Fannie Mae and Freddie Mac mortgage-backed securities, among others. The remaining principal balance (RPB) is the basis for calculation of the purchase price of the securities.
The investors in the mortgage-backed security market are typically large institutions handling an extensive number of portfolios, each portfolio including a variety of amounts and types of mortgage-backed securities. These securities are often traded, sold or bought (hereinafter collectively referred to as “trades” or “transactions”). Each of these transactions must be evaluated to determine the net losses or gains to apply to the associated portfolio. Typically, the daily volume of transactions involving such securities is extremely high, making it cumbersome if not impossible to calculate the net losses of gains by hand. The procedure is further complicated by possible fluctuations of the pass through coupon rate (also referred to hereinafter as simply “coupon”) and RPB factor (also referred to hereinafter as simply “factor”) which must be updated prior to evaluating these transactions.
It would be beneficial therefore, to provide a system and method for automatically tracking trades involving pass-through securities, such as mortgage-backed securities, and updating factors and coupons for the corresponding pass-through securities, as needed, in a convenient, efficient and effective manner.